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Should I guarantee my child's loan?

Olivia Maragna

My daughter is buying a house and her bank has told her that she will have to pay over $10,000 in mortgage insurance because her deposit is only small. She has asked if we can be their guarantor. I want to help her but at the same time I don’t want to go into this blindly. I would value your opinion on this.

Olivia says:

When a borrower doesn’t have a sufficient deposit for a loan, the lender will require the borrower to pay mortgage insurance to insure against defaulting on the loan. The deposit required to avoid this is usually around 20 per cent but this can vary amongst lenders.

Lenders mortgage insurance can add many thousands of dollars to the cost of the loan however one way around this is to ask a family member to be a guarantor if the borrower defaults.

This guarantee often involves using your own home as security so if you have been asked to act as guarantor, you should be aware of exactly what you are risking before saying yes.

So what is at risk?

Depending on the terms of the loan guarantee, if the borrower defaults, the lender may require the guarantor to assume the repayment schedule, or they may ask for the full repayment of the loan amount. This means that you could be liable to repay tens or even hundreds of thousands of dollars immediately.

Assuming you don’t have this amount of money handy, the lender will sell the home held as security to recover the debt as quickly as possible. They may offer the house at auction which could result in a sale lower than the outstanding debt which means that you will need to repay the outstanding amount.

Assuming you are still unable to pay the money owed, the lender may expect you to sell assets in order to raise the cash. If you have used your own home as security, they may even be able to force the sale of your home to repay the debt. So not only can your child lose their home but you can potentially lose yours also.

What else can happen?

If a default occurs, you could end up with a bad credit rating or in severe cases, even be declared bankrupt, both of which will severely impact yours and your daughter’s ability to borrow for several years. Although not intentional, this can also put a huge strain on family relationships.

How can you avoid these potentially dire circumstances?

Schedule a meeting with the lender to discuss exactly what the terms of the guarantee will be and to what extent you are guaranteeing. Then before signing anything, get advice from an independent professional to confirm what your obligations will be.

There are several options when guaranteeing a loan, including guaranteeing a portion of the loan rather than the full amount. Alternatively, if you have enough cash available to make up the required deposit for your child, you can lend or gift this to your child and avoid the need to guarantee the loan. This will avoid the need to pay lenders mortgage insurance.

If you choose this option, remember that there is a strong possibility that your child may not be in a position to repay you for many years and a formal loan document should be drawn up by your legal professional outlining the conditions of the loan, interest rate and expected repayments to avoid any issues down the track or even in the case that your daughter goes through a divorce.

Alternatively and probably the more difficult option emotionally, you can always say no. It may result in some ill feeling in the short term, but you may find it to be the best course of action for all involved, particularly if they are borrowing more than they can handle.

Why not increase the financial savviness of those around you – pay it forward and pass on these tips to your family, friends and kids.

Olivia Maragna is the co-founder of Aspire Retire Financial Services and is a respected and independent financial expert. Olivia’s advice is general in nature and readers should seek their own professional advice before making any financial decisions.

2 comments so far

The author here has not given any alternatives. I think Roger has some options here. He could offer to pay the morgage insurance himself. He could then have the peace of mind that the debt would be managed correctly if his daughter gets into any trouble.

Also, If he was able to access some more funds, he could add a few thousand to his daughters deposit. This would get her past the issue of having mortgage insurance in the first place, then that approx. 10,000 cost is negated. He could choose to take a stake in his daughters property, collecting his money back when she sells, or alternatively considering it a gift.

Both of these options place no risk towards Rogers own home.

All options have their risks and rewards. I think that going guarantor is a complicated process and the alternatives should be discussed. Roger (and his daughter) both need to seek advice on their circumstances.

Dallas

Commenter

Dallas

Location

South Brisbane

Date and time

August 05, 2014, 3:12PM

In most of these situations it goes bad when the guarantor is asset rich but cash flow poor, such as retired parents who own their own home.

In Asia many parents help their children buy their first house, so there is no reason why you can't do this. From gifting, part ownership relationships and so on.

However the most important issue is to work out if your children are financially able to take on the loan or not. In most cases if they can't get the deposit together themselves then the answer is no. However the are plenty of times when an opportunity to buy comes along, prices are low and expected to rise for example, and your involvement makes sense. I would just try and make sure you have some contractual right to the property for your contribution.